Can options exchanges accurately predict how well their quote mitigation plans will work?
The Securities and Exchange Commission has doubts. The regulator is unsure whether plans will reduce quote traffic as believed once some options are quoted in penny increments.
A six-month pilot program that allows but does not require 13 options classes to be quoted in penny increments will start later this month. All six options exchanges will participate.
All six have also submitted plans to the regulator that spell out how they will reduce some of the anticipated increase in quote message traffic. These “quote mitigation” plans are a response to longstanding industry concerns that quoting in pennies will create capacity problems by increasing message traffic. The SEC required these plans from the exchanges.
But the SEC isn’t sure about the plans’ prospects and exactly what they should accomplish. “The question of how much mitigation [is the right amount] is a hard one,” said Elizabeth King, associate director of the SEC’s Division of Market Regulation at a recent Futures Industry Association Expo Conference in Chicago. “It’s hard to know what the baseline should be-10 percent or 20 percent from where?”
King indicated that the quote mitigation plans offered by exchanges are based on a lot of guesswork. The Arca Options plan, for example, expects a reduction of 20 to 30 percent in the overall quotation message traffic it sends to OPRA, the Options Price Reporting Authority. “I’m sure it’s a good-faith estimate, but they could be completely wrong,” she said. Arca Options intends to send quote messages to OPRA only for “active” options series. According to the exchange, these include those that traded in the last two weeks, are sole-listed on NYSE Arca, or for which the exchange has an order.
The other exchanges have taken different approaches to quote mitigation. The International Securities Exchange, American Stock Exchange and Boston Options Exchange intend to hold back market makers’ quote updates in response to changes in the underlying security by less than one second in order to update all market makers quotes at once, instead of individually. The ISE and Amex also intend to delist inactive options.
The Chicago Board Options Exchange will limit market makers’ obligations to provide continuous two-sided quotes to options with less than nine months until expiration, and will delist low-volume options. The Philadelphia Stock Exchange plans to limit quote updates when the size associated with the exchange’s previously disseminated best bid or offer increases by less than a predetermined percentage.
The pilot ends next July. By then, the SEC is expected to have sufficient information about how penny increments affect message traffic and how much the various quote mitigation plans reduce that traffic.
Penny Pilot: Baker’s Dozen
* QQQQ: Nasdaq 100 Index Tracking Stock
* IWM: iShares Russell 2000 Index
* SMH: Semiconductor Holders Trust
* GE: General Electric Company
* AMD: Advanced Micro Devices
* MSFT: Microsoft Corp.
* INTC: Intel Corp.
* CAT: Caterpillar Inc.
* WFMI: Whole Foods Market Inc.
* TXN: Texas Instruments Inc.
* A: Agilent Tech Inc.
* FLEX: Flextronics International Ltd.
* SUNW: Sun Micro Systems Inc.